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DEMAND ESTIMATION & FORECASTING

Dr Sayyid Salman Rizavi
Hailey College of Commerce University of the Punjab Lahore

PLAN OF LECTURES Lecture 1: Demand Analysis-I Lecture 2: Demand Analysis-II Lecture 3: Demand Estimation I Lecture 4: Demand Estimation II Lecture 5: Demand Forecasting .

LAW OF DEMAND Demand: A relationship of price and quantity demanded shown by a ‘demand function’ Quantity demanded: The amount of goods purchased at a specific price Law of demand: Demand varies inversely with price ceteris paribus Extension and contraction in demand: changes in quantity demanded caused by price changes Shifts in demand (rise & fall): shifts in the demand curve caused by changes in factors other than price Demand function: A function showing what impacts the quantity demanded .

<0 >0 <0 Normal Good = = ℎ = = ℎ Inferior Good Substitute: A good that is alternatively demanded > Complimentary good: A good that is jointly demanded < Individual demand & market demand: Market demand curve is the horizontal summation of individual demands <0 >0 <0 Giffen Good . . .DEMAND FUNCTION = = = . .

where b > 0 for normal goods Qd= a – b P + c Y .g. Power form) Qd = a P b c Qd = a P Y b Price Price Price Price Non-linear Demand Curve Quantity Demanded .SPECIFICATION OF DEMAND FUNCTION Linear: Qd= a – b P . where b > 0 & c > 0 for normal goods Quantity Quantity Quantity Quantity Quantity Quantity Linear Demand Non-linear (e.

CHANGES IN DEMAND a Fall b Price c d Rise Rise in Demand (Normal good): •Increase in income •Increase in price of substitute •Decrease in price of complimentary good •Increase in Population •Development of taste e Quantity demanded Movements: Extension & Contraction Shifts: Rise & Fall .

ELASTICITY OF DEMAND In order to increase TR Should we increase the price or decrease it? The answer depends on the reaction of the consumer to prices changes. Inelastic and elastic demand Price Elasticity measures the response of the consumer to price changes Percentage change in quantity demanded = Percentage change in price .

PRICE ELASTICITY OF DEMAND = = ∆ ∆ ∆ ∆ Percentage change in quantity demanded Percentage change in price B A = slope of demand curve OR = P1 ∆P P2 Ed < 1 Ed > 1 Q1 Q2A Q2B .

OTHER ELASTICITIES = = 0< ∆ ∆ Percentage change in quantity demanded Percentage change in income = OR <0 <1 = = ∆ ∆ Percentage change in quantity demanded of a commodity Percentage change in price of other related commodity ′y OR = >0 <0 .

2 Long Run 2.9 2.9 0.67 0.41 0.3 0.9 0.6 10 .1 0.46 0.SELECTED ELASTICITIES OF DEMAND Product Clothing Tobacco products Medical care and hospitalization Jewelry & Watches Gasoline/Petrol Short Run 0.

94 1.06 0.36 11 .SELECTED INCOME ELASTICITIES OF DEMAND Product Household Electricity Beef Chicken Flour Short Run 1.28 -0.

r. of Butter Electricity Food Food Cross price elasticity 1.SELECTED CROSS ELASTICITIES OF DEMAND Cross elasticity w.8 Product Margarine Natural Gas Entertainment Clothing 12 .r.8 -0.t. price w.53 0.t.72 -1.

Is this coffee a normal good? It is elastic or inelastic? What will happen if the advertisement expenditure rises by 2 percent What will happen if the advertisement expenditure rises by 2 percent and incomes rise by 5 percent What will happen if the advertisement expenditure rises by 2 percent. ℎ ℎ = 2.8 + 2. = 2.5. given at page 130 in the fourth edition) . = 0.8.5 − 3. incomes rise by 5 percent and price of sugar falls by 8 percent? Solve the integrated problem 12 from your text book (Salvatore. = + ∆ + ∆ + ∆ + ∆ + ∆ + ∆ .5.0 − 0. .USING ELASTICITIES I A coffee company markets coffee brand X and estimates the following demand function : ℎ = = = = = • • • • • Hint: ′ = 1.0 = + 0.2 ℎ ℎ .6 + 1. = 1. = 1 Find quantity demanded of x and all possible elasticities and interpret them.

0 = + 1. . = $1. 4th edition): The research department of the corn Flakes Corporation estimated the following regression of the demand of the cornflakes it sells: ℎ = = = = = ℎ = 1. increases advertising by 20%. .5 + 0. = $4.8 . rises by 5%. ℎ This year. 10 10 . (c) estimate the level of sales next year if CFC reduces by 10%. . − 3. (d) By how much should CFC change its advertising if it wants its sales to be 30% higher than this year? Also interpret the marginal effects (slope coefficients) of the estimated demand function. = $2. = $2.5.0 + 1. = $2 (a) Calculate the sales of CFC cornflakes this year. (b) calculate the elasticity of sales with respect to each variable in the demand function.0 − 2. is reduced by 10% and remains unchanged.0 10 .USING ELASTICITIES II Problem from Salvatore (problem 12 page 130.

Y = 5.2 + 0. by how much should she raise the price? (d) if P = 20. A = 1 then compute the elasticity with respect to each independent variable in the equation (e) What will be the quantity demanded if P increases by 10% and Py decreases by 10%? (f) Are the products by XYZ and ABC complimentary goods or substitutes? .8 Where Q = Quantity demanded in thousands per month P = price of the product in Rs. Py = 18.4 + 2.USING ELASTICITIES III XYZ corporation estimated the following demand function in 2010: = 1500 − 5. what effect will this have on the firm’s sales (c) If XYZ wants to raise its price to offset the effects of increase in income.8 − 1. Y = per capita disposable income in thousands of rupees Py = price of a product by ABC corporation A = Advertisement expenditure in thousands of rupees Answer the following: (a) Interpret the marginal effects. (b) During next year per capita income may increase by 2500 rupees.